UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

o        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to          

 

Commission File Number 001-32942

 

EVOLUTION PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

2500 CityWest Blvd.,1155 Dairy Ashford Road, Suite 1300,425, Houston, Texas 7704277079

(Address of principal executive offices and zip code)

 

(713) 935-0122

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year if changed since last report)

 

EVOLUTION PETROLEUM CORPORATION AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

See accompanying notes to consolidated condensed financial statements.

Evolution Petroleum Corporation and Subsidiaries

Consolidated Condensed Statements of Cash Flows

(Unaudited)

 

Note 43 — Prepaid Expenses and Other Current Assets

As of December 31, 2015September 30, 2016 and June 30, 20152016, our prepaid expenses and other current assets consisted of the following:

As of December 31, 2015September 30, 2016 and June 30, 20152016, our oil and natural gas properties and other property and equipment consisted of the following:

During the sixthree months ended December 31, 2015September 30, 2016, the Company incurred capital expenditures of $6.3$2.8 million for the Delhi field, including approximately $4.4$2.4 million for the NGL plant project which is currently in progress. We have incurred approximately $9.4$23.9 million on a cumulative basis for the NGL plant out of a total authorized commitment of $24.6 million.

As of December 31, 2015September 30, 2016 and June 30, 20152016, other assets consisted of the following:

As of December 31, 2015September 30, 2016 and June 30, 20152016, our other current liabilities consisted of the following:

Our asset retirement obligations represent the estimated present value of the amount we will incur to plug, abandon and

remediate our producing properties at the end of their productive lives in accordance with applicable laws. The following is a

(a) Liabilities incurred during fiscal 2015 relateWe conveyed our interest in a well to the previous operator in exchange for the assumption of our shareasset retirement obligation.

(b) We expect to retire our three remaining operated wells within the next twelve months. After such operations are completed, our asset retirement obligations will consist entirely of the the estimated abandonment costs of the wells and facilitiesour working interest obligations in the Delhi field subsequent to the reversion of our working interest.field.

Note 98 — Stockholders’ Equity

Commencing in December 2013, the Board of Directors initiated a quarterly cash dividend on our common stock at a quarterly rate of $0.10 per share and subsequently adjusted this rate to $0.05 per share during the quarter ended March 31, 2015. During the sixthree months ended December 31, 2015,September 30, 2016, the Company declared twoone quarterly dividendsdividend on its common stock and paid $3,268,319$1,652,290 to its common stockholders.

On May 12, 2015, the Board of Directors approved a share repurchase program covering up to $5 million of the Company's common stock. CommencingSince commencing in June 2015, 265,762 shares have been repurchased at an average price of $6.05 per share (totaling $1,609,008) including 202,390. There has been no shares purchased duringrepurchased in the six months ended December 31, 2015, at an average price of $5.80 (totaling $1,173,899).open market since mid-December 2015. Under the program's terms, shares are repurchased only on the open market and in accordance with the requirements of the Securities and Exchange Commission. Such shares are initially recorded as treasury stock, then subsequently canceled. The timing and amount of repurchases depends upon several factors, including financial resources and market and business conditions. There is no fixed termination date for this repurchase program, and the repurchase programit may be suspended or discontinued at any time. Such

During the three months ended September 30, 2016, the Company acquired 58,147 shares are initially recorded asof treasury stock thenat an average cost of $5.68 per share (totaling $330,070) from holders of newly vested stock-based awards to fund the recipients' payroll taxes paid in the quarter. The treasury shares were subsequently canceled.

At December 31, 2015, there wereOn September 30, 2016, the Company declared the preferred dividend for the month of October 2016 and elected to redeem all 317,319 outstanding shares of the Company’s 8.5% Series A Cumulative (perpetual) Preferred Stock outstanding.  Stock. The redemption will occur on November 14, 2016 at the issue's $25.00 per share liquidation value plus all accumulated and unpaid distributions from October 31, 2016 (the last dividend payment date before the redemption date) through the redemption date, for an aggregate redemption price of approximately $25.082639 per share:

The Series A Cumulative Preferred Stock cannot be converted into our common stock and there are no sinking fund or redemption rights available to the holders thereof. Effective July 1, 2014, we can redeem this preferred stock at any time for the stated liquidation value of $25.00 per share plus accrued dividends. With respect to dividend rights and rights upon our liquidation, winding-up or dissolution, the Series A Preferred Stock ranks senior to our common stockholders, but subordinate to any of our existing and future debt.  Dividends on the Series A Cumulative Preferred Stock accrue and accumulate at a fixed rate of 8.5% per annum on the $25.00 per share liquidation preference, payable monthly at $0.177083 per share, as, if and when declared by our Board of Directors through its Dividend Committee. We paid dividends of $337,151$168,575 to holders of our Series A Preferred Stock during each of the six month periodsthree months ended December 31, 2015September 30, 2016 and 2014.2015.

Expected Tax Treatment of Dividends

For the fiscal year ended June 30, 2015, 100% of cash2016, we expect all preferred and common dividends on preferred stock wereto be treated for tax purposes as qualified dividend income. Approximately 86% of cash dividends on common shares were treated as a return of capitalincome to stockholders and the remainder of 14% were treated as qualified dividend income.recipients. Based on our current projections for the fiscal year ending June 30, 2016,2017, we expect all common and remaining preferred and common dividends for such period will be treated as qualified dividend income.

Note 109 — Stock-Based Incentive Plan

Under the terms of the Evolution Petroleum Corporation Amended and Restated 2004 Stock Plan (the "Plan"), we have granted option awards to purchase common stock (the "Stock Options"), restricted common stock awards ("Restricted Stock"), contingent restricted common stock awards ("Contingent Restricted Stock") and/or unrestricted fully vested common stock, to employees, directors, and consultants of the Company. The Plan authorizes the issuance of 6,500,000 shares of common stock prior to its expiration on October 24, 2017 and 257,1882017. As of September 30, 2016, 64,236 shares remain available for grant as of December 31, 2015.under the Plan.

Stock Options

Restricted Stock and Contingent Restricted Stock

Prior to August 28, 2014, all Restricted Stock grants contained a four-year vesting period based solely on service. Restricted Stock which vests based solely on service is valued at the fair market value on the date of grant and amortized over the service period.

In August 2014, and in December 2015 and September 2016, the Company awarded grants of both Restricted Stock and Contingent Restricted Stock as part of its long-term incentive plan. Such grants, which expire after four years if unvested, contain service-based, performance-based and market-based vesting provisions. The common shares underlying the Restricted Stock grants were

Performance-based grants vest upon the attainment of earnings, revenue and other operational goals and require that the recipient remain an employee of the Company through the vesting date. The Company recognizes compensation expense for performance-based awards ratably over the expected vesting period based on the grant date fair value when it is deemed probable, for accounting purposes, that the performance criteria will be achieved. The expected vesting period may be deemed to be shorter than the four- yearfour-year term. As of December 31, 2015,September 30, 2016, certain performance-based awards were not considered probable of vesting for accounting purposes and no compensation expense has been recognized with regard to these awards. If these awards are later determined to be probable of vesting, cumulative compensation expense wouldwill be recorded at that time and amortization would continue over the remaining expected vesting period.

Market-based awards granted in 2014 and 2015 entitle employees to vest in a fixed number of shares when the three-year trailing total return on the Company’s common stock exceeds the corresponding total returns of various quartiles of companies comprising the SIG Exploration and Production Index (NASDAQ EPX) during defined measurement periods. Market-based awards granted in 2016 entitle employees to vest in a fixed number of shares when the three-year trailing total return on the Company’s common stock exceeds the corresponding total returns of various quartiles of an index consisting of designated peer companies during defined measurement periods. The fair value and expected vesting period of these awards were determined using a Monte Carlo simulation based on the historical volatility of the Company's total return compared to the historical volatilities of the other companies in the index. During the sixthree months ended DecemberSeptember 30, 2015,2016, we granted market-based

Unvested Restricted Stock awards at December 31, 2015September 30, 2016 consisted of the following:

Stock-based compensation expense related to Restricted Stock and contingentContingent Restricted Stock grants for the three months ended December 31,September 30, 2016 and 2015 was $311,688 and 2014 was $272,063 and $245,020,$218,115, respectively. For the six months ended December 31, 2015 and 2014, this expense was $490,178 and $488,357, respectively.

In early June 2015, the Company began using derivative instruments to reduce its exposure to crude oil price volatility for a substantial portion of its near-term forecasted productionproduction. The Company's objectives for this program were to achieve a more predictable level of cash flows to support the Company’s capital expenditure program and to provide better financial visibility for the payment of dividends on common stock. The Company uses both fixed price swap agreements and costless collars the Company uses to manage risk are designedits exposure to establish floor and ceiling prices on anticipated futurecrude oil production.price risk. While the use of these derivative instruments limitsare intended to limit the downside risk of adverse price movements, they may also limit future revenues from favorable price movements. We also use swap agreements in which we exchange our exposure to floating crude spot prices for a fixed price for our production over a period of time.

The Company does not intend to enter into derivative instruments for speculative or trading purposes.

These derivative instruments can result in both fair value asset and liability positions held with that counterparty, whicheach counterparty. These positions are all offset to a single net fair value asset or liability at the end of each reporting period. The Company nets its fair value amounts of derivative instruments executed with the same counterparty pursuant to ISDA master agreements, which provide for net settlement over the term of the contract and in the event of default or termination of the contract. The fair value derivative instruments where the Company is in a net asset position with its counterparty as of December 31, 2015 totaled $1,323,749. Refer to Note 12—Fair Value Measurement for derivative asset and derivative liability balances before offsetting.

For the sixthree months ended December 31,September 30, 2016, the Company recorded in the consolidated statement of operations a loss on derivative instruments of $14,042 consisting of a realized gain of $90 on settled derivatives and an unrealized net loss of $14,132 on unsettled derivatives. For the three months ended September 30, 2015, the Company recorded in the consolidated statement of operations a gain on derivative instruments of $3,598,351$1,938,389 consisting of a realized gain of $2,164,628$866,427 on settled derivatives and an unrealized net gainloss of $1,433,723$1,071,962 on unsettledunrealized derivatives.

Accounting guidelines for measuring fair value establish a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy categorizes assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement.

The three levels are defined as follows:

We file a consolidated federal income tax return in the United States and various combined and separate filings in several state and local jurisdictions.

There were no unrecognized tax benefits nor any accrued interest or penalties associated with unrecognized tax benefits during the sixthree months ended December 31, 2015.September 30, 2016.  We believe we have appropriate support for the income tax positions taken and to be taken on our tax returns and that the accruals for tax liabilities are adequate for all open years based on our assessment of manyvarious factors including past experience and interpretations of tax law applied to the facts of each matter. The Company’s federal and state income tax returns are open to audit under the statute of limitations for the years endingended June 30, 20122013 through June 30, 20142015 for federal tax purposes and for the years ended June 30, 2011 through June 30, 20142015 for state tax purposes. To the extent we utilize net operating losses generated in earlier years, such earlier years may also be subject to audit.

We recognized income tax expense of $889,176 and $1,754,969 for the three months ended September 30, 2016 and 2015, respectively, with corresponding effective rates of 33% and 36%. Our effective tax rate will typically differ from the statutory federal rate as a result of state income taxes, primarily in the stateState of Louisiana, with smallerand differences related to stock basedpercentage depletion in excess of basis, stock-based compensation and other permanent differences. Statutory percentage depletion gives rise to a permanent difference in our tax rates when utilized for state or federal income tax purposes.

Outstanding potentially dilutive securities as of December 31,September 30, 2016 were as follows:

Outstanding potentially dilutive securities as of September 30, 2015 were as follows:

Note 1514 — Unsecured RevolvingSenior Secured Credit Agreement

In connection with this agreement, the Company incurred $168,972 of debt issuance costs. Such costs were capitalized in Other Assets and are being amortized to expense. The unamortized balance in debt issuance costs related to the Credit AgreementFacility was $8,093$140,925 as of December 31, 2015. The Company is in discussions with the Lender to extend the maturity, renew the current unsecured Credit Agreement or seek a similar source of bank financing.September 30, 2016.

Note 1615 — Commitments and Contingencies

We are subject to various claims and contingencies in the normal course of business. In addition, from time to time, we receive communications from government or regulatory agencies concerning investigations or allegations of noncompliance with laws or regulations in jurisdictions in which we operate. At a minimum we disclose such matters if we believe it is reasonably possible that a future event or events will confirm a loss through impairment of an asset or the incurrence of a liability. We accrue a loss if we believe it is probable that a future event or events will confirm a loss and we can reasonably estimate such loss and we do not accrue future legal costs related to that loss. Furthermore, we will disclose any matter that is unasserted if we consider it probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable. We expense legal defense costs as they are incurred.

On December 3, 2013, our wholly owned subsidiary, NGS Sub Corp., was served with a lawsuit filed in the 8th Judicial District Court of Winn Parish, Louisiana by Cecil M. Brooks and Brandon Hawkins, residents of Louisiana, alleging that in 2006 a former subsidiary of NGS Sub Corp. improperly disposed of water from an off-lease well into a well located on the plaintiffs’ lands in Winn Parish. The plaintiffs requested monetary damages and other relief. NGS Sub Corp. divested its ownership of the property in question along with its ownership of the subsidiary in 2008 to a third party. The district court granted our exception of no right of action and dismissed certain claims against NGS Sub Corp. The plaintiffs subsequently filed an amended petition naming NGS Sub Corp. and the Company as defendants. NGS Sub Corp. and the Company have denied the plaintiffs’ claims. Various pretrial motions filed on behalf of multiple parties were recently decided by the court and discovery is in process. We will continue to vigorously defend all claims by plaintiffs and consider the likelihood of a material loss to the Company in this matter to be remote.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto contained herein and in our Annual Report on Form 10-K for the year ended June 30, 20152016 (the “Form 10-K”), along with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Form 10-K.  Any terms used but not defined herein have the same meaning given to them in the Form 10-K.

This Form 10-Q and the information referenced herein contain forward-looking statements within the meaning of the Private Securities Litigations Reform Act of 1995, Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934. The words “plan,” “expect,” “project,” “estimate,” “assume,” “believe,” “anticipate,” “intend,” “budget,” “forecast,” “predict” and other similar expressions are intended to identify forward-looking statements. These statements appear in a number of places and include statements regarding our plans, beliefs or current expectations, including the plans, beliefs and expectations of our officers and directors. When considering any forward-looking statement, you should keep in mind the risk factors that could cause our actual results to differ materially from those contained in any forward-looking statement. Important factors that could cause actual results to differ materially from those in the forward-looking statements herein include the timing and extent of changes in commodity prices for oil and natural gas, operating risks and other risk factors as described in our 20152016 Annual Report on Form 10-K for the year ended June 30, 20152016 as filed with the Securities and Exchange Commission. Furthermore, the assumptions that support our forward-looking statements are based upon information that is currently available and is subject to change. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and therefore disclaim any resulting liability for potentially related damages. All forward-looking statements attributable to Evolution Petroleum Corporation are expressly qualified in their entirety by this cautionary statement.

Executive Overview

General

Highlights

Liquidity and not included in revenues.Capital Resources

On September 30, 2016 the Board of Directors approved the redemption of all of the Company's 8.5% Series A Cumulative Preferred Stock to occur on November 14, 2016. Though reduced by this transaction, working capital remains strong at $13.7a healthy level and the Company also has access to capital at a significantly lower cost from its existing undrawn credit facility.